Decentralized finance is the hot ticket of 2020. How can you take advantage of everything the DeFi industry has to offer?
This guide to getting a cryptocurrency loan answers a few of the vital questions surrounding decentralized finance offerings.
Below, find out what a cryptocurrency loan is, how to apply for a crypto loan, and the best cryptocurrency lending platforms today.
Cryptocurrency Loans Explained
Since the advent of Bitcoin back in 2009, cryptocurrencies have been used as a form of decentralized finance. Every Bitcoin transaction is an act of decentralized finance since the Bitcoin network is, well, decentralized.
Basically, decentralized finance refers to peer-to-peer money services that you would normally use a bank or other centralized financial institution to accomplish.
While Bitcoin and other cryptocurrencies have revolutionized money, cryptocurrency lending platforms change the way people borrow money and earn interest on their assets.
Differences between traditional loans and crypto loans
A cryptocurrency loan is built in much the same way as a normal loan — a borrower borrows, and a lender lends.
Difference #1 is in a standard loan, there is a bank between borrower and lender (or the bank also acts as the lender). Cryptocurrency lending platforms remove the third party and provide a blockchain-backed protocol for counterparties to negotiate loan terms and carry them out.
So, just in the way Bitcoin took the concept of money and made it peer to peer, crypto loan platforms have similarly made lending a peer-based service.
Difference #2 is that to get a crypto loan, there are no credit checks required. In fact, there are no checks of any kind required apart from standard KYC verification (sometimes). Why?
Because to get a crypto loan, you must put up cryptocurrency as collateral. In the traditional loan space, you can often get a risky uncollateralized loan — a practice that helped cause 2008's Great Recession.
In the crypto loan industry, you're required to over-collateralize your loan to protect the lender's assets and ensure that you have the financial standing to get a loan in the first place.
This model protects both sides, making it possible to remove third-party guarantors from the entire arrangement.
Cryptocurrency as collateral — OK, cool, but how does market volatility factor in?
You've collateralized your loan with cryptocurrency assets. This allows you to stay in the crypto market while simultaneously hitting them for cash liquidity.
That's a win-win, right? But what happens when the value of your cryptocurrency assets in collateral goes up...or down?
It's at this point you should get to know a very important mechanism — LTV ratio. The LTV stands for Loan to Value and represents the ratio between deposited collateral and loan amount.
Most crypto lending platforms enforce a 50% LTV ratio, meaning that as a minimum, you'll need to deposit 2X the amount you're borrowing as collateral.
If a Bitcoin is worth $10,000, and you want to borrow $20,000 cash, then you'll need to deposit 4 BTC as collateral. When you finish paying off the loan, you get your collateral back — simple as that.
Going back to the volatility point — what happens when BTC values rise or fall? If it grows, then your LTV ratio gets more and more favorable since, in effect, you're depositing more collateral. You can take out additional cash against your added value, or get out of your current loan in profit.
If BTC values fall, your LTV ratio goes up, meaning you effectively have less collateral protecting your loan. If it goes too high, and you don't deposit more collateral to bring the LTV ratio down, your collateral will be liquidated in a margin call to protect the lender's assets.
Can I collateralize a loan with physical assets?
Maybe you don't want to collateralize your loan with crypto because:
Crypto is volatile
You don't own any
You have other collateral
Nonetheless, maybe you still like the idea of decentralized lending, no credit checks, instant approval, and a bankless financial ecosystem.
There is still a way to get a crypto loan without crypto thanks to blockchain oracles like Chainlink.
Chainlink lets blockchains have a two-way conversation with off-chain data sources. Some crypto lending platforms have integrated Chainlink, enabling borrowers to collateralize their loans with automobiles, real estate, and other off-chain assets.
How long does it take to get approved for a crypto loan?
Getting a crypto loan is usually instant. The entire process revolves around two things:
Verifying your identity
Identity verification, known as KYC, happens within minutes, while depositing collateral depends on how quickly your digital assets move through the blockchain.
However, if you're using a truly decentralized finance platform, there are zero KYC checks required. That means you just need to agree to loan terms with a lender and deposit your collateral to get started.
What's in it for lenders? Can I earn interest?
On the flip side of the cryptocurrency loan space are lenders. You're a lender if you don't want a loan but want to earn interest in your crypto, stablecoins, or cash assets.
To incentivize lenders, decentralized finance platforms offer high-yield interest rates paid out on a regular (usually weekly) basis.
Generally, fiat currency and stablecoin deposits earn the highest interest of between 8% and 11% APY. Cryptocurrency deposits of BTC, ETH, and other major digital assets typically earn between 4% and 6%.
No matter how you slice it, crypto savings accounts are much higher yielders than legacy banking equivalents. A typical "high yield" savings account in the banking industry will net a 1% APY return — a paltry amount compared to using a Bitcoin savings account.
Additionally, there is no lock-up period for your deposited assets required, meaning you can withdraw them while still redeeming the accumulated interest.
You'll find the highest rates at semi-centralized crypto lending platforms, but more on that later.
Cryptocurrency Loan Platforms Compared
There are two groups of decentralized finance platforms you should know about.
The first group is truly decentralized, meaning the entire platform runs on blockchain and smart contracts.
The second group is semi-centralized meaning they still use blockchain infrastructure at some level, and maybe even smart contracts, but they generate profits, have CEOs, and operate like regular companies.
Decentralized Loan Platforms
Compound — Compound's own description is as follows:
algorithmic, autonomous interest rate protocol built...to unlock a universe of open financial applications
If that seems a little complicated, the simple version is that Compound is a money market allowing you to deposit interest-yielding cryptocurrency generated by borrowers.
Access Compound's features using the native app, or other apps that integrate the Compound protocol, such as Dharma.
Aave— Similar to Compound, Aave is another open-source DeFi money market enabling you to generate interest on your crypto assets or borrow them. With nearly $500 million in assets locked inside of Aave's existing money markets, it's safe to say that the protocol has caught on with users.
dYdX— Backed by Polychain Capital and Andreessen Horowitz, two of cryptocurrency's most influential VC funds, dYdX is a decentralized exchange for leveraged trading, lending, and borrowing crypto assets.
Centralized Loan Platforms
YouHodler— Receive instant cash loans using cryptocurrency as collateral. YouHodler accepts the top 20 coins, with minimum loan amounts as low as $100 and loan to value ratio's (LTV) as high as 90%. YouHodler uses Ledger Vault as a custodian, which comes with a $150 million crime insurance pool.
Nebeus - A European blockchain platform helping customers take advantage of their crypto assets in everyday lives. Founded in 2014, Nebeus offers a variety of fast and secure crypto-backed services, such as crypto-backed loans, crypto savings accounts and quick money transfers to Visa and Master cards in over 150 countries worldwide from Nebeus digital crypto wallet.
Cryptocurrency Lending Platforms
Celsius Network — Celsius has originated over $1 billion in loans making it the far and away most popular cryptocurrency loan platform in existence today. Celsius is accessed via the Celsius App and makes borrowing or generating interest simple and painless.
If you're wondering about insurance policies, then you've wandered into a contentious point for Celsius. While not officially insuring your wallet, Celsius does use BitGo as a custodian. BitGo, in turn, has a $100 million theft insurance policy with Lloyd's of London.
BlockFi— Like Celsius but offering fewer depositable cryptocurrencies, BlockFi is an industry stalwart yielding solid APY to lenders. If you have cryptocurrencies that aren't named Bitcoin, Ethereum, and Litecoin, BlockFi may not be the right platform for you.
BlockFi's longevity in the crypto lending space means the platform's team is deeply experienced, perhaps more so than any other, and offers a solid user experience that has been smoothed out by trial and error.
Nexo— Nexo prides itself on offering borrowers and lenders a wide range of accepted cryptocurrencies. As a borrower, you can deposit a big mix of digital assets that total up to your desired collateral amount. This option makes Nexo really stand out against both BlockFi and Celsius. It's APY rates, however, are identical to the other two.
Should You Get a Crypto Loan?
Whether you should get a cryptocurrency loan or not is entirely up to you.
However, there are plenty of advantages for anyone seeking to borrow money, earn interest on stored crypto assets, or simply get away from bankers.
The decentralized finance industry is still young, so watch this space as offerings become more robust, mainstream, and accessible for everyone.
You can also find 4 great reasons to put your bitcoin up as collateral instead of selling it, provided by the experts of CryptoManiaks
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